It took six meetings for cracks to become visible within India’s powerful interest rate-setting panel.

Following a series of consensus voting and bland statements, there was open dissent on the monetary policy committee in June, which only worsened last week when a member of the Reserve Bank of India’s economic research wing broke ranks for the first time with his bosses, governor Urjit Patel and deputy Viral Acharya. The 5-1 vote for a cut isolated career central banker Michael Patra against the relative newcomers on the year-old MPC.

“To me that is quite significant," said Sujan Hajra, Mumbai-based chief economist at Anand Rathi Financial Services Ltd, who has been a director at the RBI. While debate is good, what stood out is how the members read the inflation model differently, with one wanting to err on the side of caution while others were keen for an inflation-growth trade off, he said.

Details on the arguments will be available when minutes are published 16 August and, to be sure, the RBI wouldn’t be the only global central bank flummoxed by a slump in inflation. Nevertheless, the split raises questions on how much trust the MPC members place in the monetary authority’s forecasting model, which has consistently overestimated price pressures.

The RBI’s inflation assessments have come under intense scrutiny after a slew of readings fell short of projections. Prime Minister Narendra Modi’s chief economic adviser Arvind Subramanian criticized forecast errors that he said are “large and systematically one-sided in overstating inflation," and called on policy makers to take a long, hard look at June’s record-low 1.5% reading.

Just three months earlier, Patra had argued for a “pre-emptive" increase in interest rates, though he ended up voting to leave borrowing costs unchanged. Last December, the RBI had forecast consumer price inflation of 5% in March with an upside bias, though the actual print was 3.9%, below the RBI’s 4% medium-term inflation target.

Very few central banks would have made such glaring errors and officials should admit that they were wrong, economist Surjit S. Bhalla, a senior India analyst at Observatory Group in New Delhi, wrote in the Indian Express. In its latest statement, the central bank acknowledged historically low inflation but reiterated its forecast that CPI will accelerate to between 3.5 and 4.5% by March 2018 and said “a conclusive segregation of transitory and structural factors driving the disinflation is still elusive."

‘No clear understanding’

To be fair, most central banks would probably find it tough to factor in the implications of Modi’s unprecedented November decision to void 86% of the nation’s currency as well as the 1 July roll out of a nationwide sales tax.

Yet, where the RBI’s model is probably flawed is that it is structured around the concept of a small, open economy, according to Rohan Chinchwadkar, assistant professor of finance and accounting at the Indian Institute of Management at Tiruchirapalli in the southern state of Tamil Nadu. That would be akin to $300 billion Singapore, while India is a $2 trillion behemoth where almost half of gross domestic product is generated by an intricate web of unregistered networks that employ more than 90 percent of workers.

“This might be one of the causes of disagreement within the RBI," Chinchwadkar said. “There is no clear model understanding of the impact of monetary policy and shocks on India-specific features like the informal sector and shadow economy. So the position of MPC members depends on their own judgment and risk preference."

An RBI spokeswoman didn’t reply to a text message last week seeking comment.

‘India-specific model’

The central bank’s staff published a working paper in November in collaboration with the International Monetary Fund, aiming to “sketch out a model with India-specific features to capture the dynamics relevant to an emerging market economy." It concluded that forecasting performance is improved by using the Bayesian statistical technique which assesses the probability of something happening based on observed data.

The current model is based on the principles of New-Keynesian economics, which evolved from classical Keynesian economics but differs in terms of how quickly prices and wages adjust. It consists of four variables: the output gap, the Phillips curve which assesses the impact of unemployment, the Taylor rule for short-term interest rates that also guides several global central banks, and interest rate parity through exchange rates.

Apart from statistical techniques, inputs of inflation are also crucial. For instance, the RBI’s measure of core CPI does not fully strip out fuel costs from its transport basket, which keeps the gauge artificially high, according to Bloomberg Intelligence’s Abhishek Gupta. There are also flaws in the consumption pattern the RBI tracks, other economists say.

All of which suggest the possibility that the RBI—Acharya and Patra’s department, to be precise—may have to return to the drawing board.

“RBI’s highly capable economists can develop parallel models based on different schools of economic thought, applied to the Indian context," Chinchwadkar said. “When the different models agree on the assessment of the economic situation and policy recommendations, the RBI can be confident about its policy actions." Bloomberg